This article is a follow-up of my first article on Sea published slightly more than a year ago. While my previous article delved extensively into Sea's fundamentals, this follow-up piece aims to offer updates in light of Sea's recent FY23 Q4 earnings.

Key insights from 2023 Q4 earnings

#1: First full financial year of profitability at both adjusted EBITDA and GAAP net income levels 🡪 Demonstrates to investors that Sea’s business model is commercially viable.

Profitability at both adjusted EBITDA and GAAP net income levels...

US$0.2b net profit in FY2023 vs US$1.7b net loss in FY2022

US$1,179.2m adjusted EBITDA in FY2023 vs negative US$878.1m adjusted EBITDA in FY2022

...Driven by:

• Modest +5% YoY revenue growth 
• Significant reduction in sales and marketing cost from 26.3% of revenue to 21.3% of revenue 
• Significant reduction in general and administrative cost from 11.5% of revenue to 8.7% of revenue 
• Significant increase in interest income from US$116m (FY22) to US$331m (FY23) due to rising interest rates also partly helped 

What does this mean for investors?: This sends a strong message to investors that Sea’s management is capable of shifting gears to focus and achieve profitability through excellent execution if it wishes to.

#2: No longer burning cash, with minimal debt against its large cash balance 🡪 Demonstrates Sea’s strong financial position to weather through future storms and intensifying competition

Huge cash war chest...

Cash have been gradually building up over despite no significant fundraising activities (+366m in cash flow from financing activities) – largely because Sea has become cash flow positive from an operating cash flow perspective. 

...Against minimal debt

The US$8.5b cash position surpasses its debt of US$4.45b (borrowings, convertible notes, operating lease liabilities). Out of which, US$2.875b are principal amount of its 0.25% convertible senior notes due 2026 at the conversion price of US$477.01 (note its share price is US$57.72 as of writing). 

‍What does this mean for investors?: This instils confidence in investors that Sea will be able to weather through storms, continue spending on sales and marketing if needed, and not be subjected to the mercy of external financing.

#3: Garena’s growth tapering off. Shopee and SeaMoney are now Sea’s twin engines to maintain momentum.

Garena’s organic slowdown: 

• As expected, Q4 2023 saw drop in Quarterly Active Users of 19.2% from Q4 2022. Average spending per paying user is down from US$73 in FY22 to US$54 in FY23. Consequently, Garena saw a 44.0% yoy drop in revenue comparing FY23 and FY22. Monetization is also down. 
• Note that Garena’s most popular and profitable title, Free Fire, was banned in Feb-22, so the significant drop is attributable to an organic slowdown in their gaming business. 
• More commentary on Garena’s outlook below.

Shopee as one of Sea’s twin growth engine: 

• Shopee saw GMV increase 29% YoY from Q4 2023 to Q4 2022. This is a significant increase from the 5% YoY increase in GMV in Q3 2023. However, note that this large increase is largely due to TikTok Shop being banned by Indonesia for a large part of the quarter. (Late Sep – Early Dec 2023). Anecdotally, many active sellers on TikTok Shop who had stocked inventory for Q4 festive season switched to Shopee Live when TikTok Shop was banned.
• Interestingly, Sea did not publish Q1 and Q2 GMV, so it’s difficult to compare full year GMV figures. Nonetheless, top-line revenue increased 23.5% from US$7.3b in FY22 to US$9b in FY23. 
• Take rates have also been gradually falling over the years, indicating increasing monetization. 
• Shopee proved itself to be profitable in Q1 and Q2 of 2023. However, it is now back to focusing on growth and remains unprofitable for Q3 and Q4. 
• More commentary on Shopee’s outlook below.

SeaMoney as one of Sea’s twin growth engine: 

• SeaMoney saw 44% yoy revenue growth from FY22 to FY23. 
• Non-performing loans due by more than 90 days as a % of loans on book remain stable at 1.6%. 
• Turned in an operating profit (adj EBIT) of US$490.2 million for 2023, reversing the operating loss of US$277.3 million in the previous year.
• Overall, growth is impressive, but note that it is coming from a relatively low base. 
• More commentary on SeaMoney’s outlook below.

How did the markets react? What is baked into Sea’s recent rally? 

How did markets react?

As seen above, markets took the news positively and the stock rallied about 32% month to date. 

My take is that the markets rallied partially due to the strong earnings results, but more so because of very positive forward guidance provided by management for 2024.

Summary below: 

1. Sea expected to continue being profitable in FY24
2. Shopee GMV growth expected to be in the high-teens yoy 
3. Garena’s free fire expected to see double-digit yoy growth in booking and users

So, what’s priced in by the markets?

Analysts are pricing in ~14% yoy revenue from in FY24. Given Sea’s lackluster 5% growth in FY23, it definitely raises questions on how realistic such expectations are. Let’s dive deeper below.

Note: I initially wanted to do up a reverse DCF to validate/derive this figure, but unfortunately did not have the time to finish it – I will probably continue working on it along the way.

Will Sea be able to achieve the market’s growth expectations? Outlook of its business segments.

Garena will no longer move the needle for Sea.

While CEO Forestt Li remains optimistic about Free Fire, the numbers don’t lie. Garena's slowdown will likely continue. As I explained in my prior quick take, this is a structural problem due to Garena’s over-reliance on (1) Free Fire and (2) titles from Tencent.

On (1): Free Fire is reaching the end of its natural lifecycle. Game popularity naturally fade over time. This happens to ALL games. – e.g. Massively popular World of Warcraft, MapleStory, etc. 

On (2): While Sea managed to renew its agreement with Tencent under existing terms, there is no longer a 5-year certainty as in the past. Tencent can opt to not renew it after each year. 

While figures may not have completely bottomed as Sea is looking to relaunch Free Fire in India, it is unlikely that Sea will be able to develop another similarly successful title in the mid-term. Having said that, Garena’s pipeline of new games, such as the newly published Black Clover M is showing some traction and will likely soften the blow.

My base case is for Garena to maintain its current revenue. 

Sea will need to rely on Shopee to fuel its 14% group level revenue growth expectations – an uphill battle given intensifying competition 

Shopee is yet again in loss making territory for Q3 and Q4 after Q1 and Q2 of profitability. This really goes to further cement our initial hypothesis that Shopee’s moat is built upon unsustainable discounts and perks (as I have written in my prior quick take). Think about it - why would someone use Shopee over Lazada/Tokopedia? The #1 and bulk of the reason will likely be price.

There are 3 main growth levers for Shopee:

1. Benefiting from increasing e-commerce pie as e-commerce penetration increases (i.e. no. ppl using e-commerce rise)
2. Benefiting from increasing e-commerce pie as spend/user increase for reasons such as rising income levels
3. Taking market share from competitors

We will focus on Indonesia and Brazil – two of Shopee’s most needle-moving markets. 

In Indonesia:

On (1) and (2): In Indonesia, the e-commerce sector is expected to grow at 15% from 2023 to 2024. [Source: Google/Bain/Temasek e-Conomy report 2023]. Hence, assuming that Shopee is able to maintain market share, it should be able to capture 15% growth in the base case. 

On (3): However, given the recent announcement by Goto and TikTok to combine Tokopedia and TikTok Shop’s Indonesia business, this will pose huge headwinds for Shopee. According to Momentum Works, Shopee has ~36% market share in Indonesia with Tokopedia (~35%) and TikTok Shop (~5%) lagging behind it. 

1. TikTok’s strong balance sheet will provide support for Tokopedia marketing spend. TikTok has already committed to spend US$1.5b and potentially more in future. 
2. Complementary user base. Tokopedia (more affluent, urban population) and TikTok (more mass market population) target pretty different segments, minimizing cannibalization. 
3. Previously, TikTok Shop's rise was downplayed due to their weaker logistics and payment infrastructure alongside focusing on a niche segment (fashion/accessories). With Tokopedia on TikTok Shop's side now, these will no longer pose as significant challenges.

According to Chris Feng (Sea's President), Shopee's moat lies in:

1. Scale, being the market leader >> My take: With Tokopedia (35% mkt share) and TikTok Shop's (5% mkt share) combination, Shopee will likely drop to #2 player (36% mkt share)
2. Leadership being familiar with the market - including learning Bahasa Indonesia >> My take: Tokopedia is a local Indonesian company
3. Local leadership team with superior local expertise and execution skills >> My take: Tokopedia is a local Indonesian company
4. Infrastructure, which reduces cost >> My take: Lazada has been heavily investing in infrastructure much before Sea. However, Sea has been investing a lot more aggressively into infrastructure since Q3 of 2021. For context, Sea's net PPE increased from US$621m in FY20 to US$1.6b in FY21, US$2.3b in FY22 and US$2.2b in FY23. Having said that, there isn't sufficient concrete data on the web (esp given Lazada is not a public company) to make a meaningful comparison on infrastructure maturity across platforms. Speaking to more people on the ground like merchants/logs providers is necessary to better triangulate the information and come up with a meaningful insight on this.
5. Integration with digital financial services >> My take: My research seems to suggest that Shopee's digital financial services may not be significantly ahead of other players like GoTo (which also share the GoPay/Tokopedia integration and synergies) [E.g. Indonesia Business Post]. Nevertheless, I have to admit that more market validation from primary sources are required to really solidify this point.

In Brazil (Shopee has already exited from all of its other LatAm markets like Chile, Argentina, Colombia):  

On (1) and (2): In Brazil, the e-commerce sector is expected to grow at a CAGR of 14.3% from 2023 to 2026. [Source: International Trade Administration]. Similarly, assuming that Shopee can maintain market share, it should be able to capture 14-15% growth in the base case. 

On (3): Mercado Libre is the market leader and has built a strong competitive advantage via its infrastructure investments (invested US$1.9bn and US$3.3bn, respectively in 2021 and 2022). Its logistics network boasts a 94% penetration rate, indicating that MELI doesn't rely on the local post office for deliveries. For comparison, MELI operates 10 fulfillment centers, 22-23 cross-docking centers, and 4.5k MELI places/stores. In contrast, Shopee has 8 cross-docking centers and, as of now, no fulfillment centers.

SeaMoney will be another important growth engine for Sea

Across Southeast Asia, digital payments and especially digital loans are still underpenetrated and a relatively nascent space – hence growth will likely be significant going forward. 

However, two important headwinds will likely dampen growth – (i) increasing regulation in this space and (ii) falling interest rates in the near-term as the Fed is looking to start cutting rates.

Concluding thoughts - Unlikely to see significant stock re-rating in the mid-term

To achieve 14% growth at the group level, Sea will need to (1) maintain Garena’s revenue (possible, our base case), (2) Shopee to grow at 14% and (3) SeaMoney to continue its 40% yoy growth. I think there is a good chance that this is achievable. However, Sea is unlikely to outperform this by a sufficient margin to warrant any significant stock re-rating. Furthermore, margins may narrow going forward given Free Fire's slowdown, funding Shopee's growth and interest rate cuts affecting SeaMoney.

More critically, Sea’s long-term fundamentals remain uncertain – with Garena slowing losing its edge, Shopee’s moat being built on unsustainable discounts and perks and SeaMoney possibly seeing tighter regulatory controls going forward.